Funds take responsible investing seriously in emerging world

BloombergStarbucks, which sources fair trade coffee beans but has been accused of underpaying tax and putting local shops out of business, is an example of the difficulties of deciding whether an investment is responsible. Photo: Bloomberg

London - Cajoled by developed world governments and shocked by disasters such as the Bangladeshi factory fire earlier this year, investors in emerging market companies are looking more closely at environmental, social and governance (ESG) issues before they buy.

Almost all emerging fund managers in a survey by UK development finance arm CDC to be published this week consider ESG to be integral to their investment strategy.

It was a sharp contrast to a few years ago, when emerging market investors saw sustainable strategies as an irritant imposed by worthy multilateral lenders or “the dead hand of eco-fascism”, said Mark Eckstein, the CDC’s ESG director.

“We are beginning to see questions from investors, such as, ‘Is this company going to be in business in five years’ time?’,” Eckstein said.

“There is a step-up in investors’ sophistication. They are taking ESG seriously because it is an issue for them.”

Sustainable investing has mushroomed. Such assets under management in Europe jumped to more than $8 trillion (R83 trillion) in 2010 from next to nothing in 2005, according to HSBC. In the US they total about $3 trillion.

But the strategy is seen as particularly likely to reap returns in emerging stocks, even though some market participants remain unsure of the consistency of returns.

Hermes runs an emerging equity fund for US ethical investment fund Calvert Investments. The fund showed an 11.6 percent return this year before sales charges, compared with a 4.7 percent fall in the MSCI emerging stocks index.

Investing in a way that removes ESG risks could boost returns in an emerging equity portfolio by up to 50 basis points, according to a 2011 study by Allianz Global Investors.

But definitions of the stocks most suitable to invest in can be muddled and reliable outperformance hard to prove.

“I think it is random, and we have been doing it for 25 years,” said Brian Langstraat, the chief executive of fund manager Parametric, which constructs portfolios for clients and has an emerging market focus.

He said investors were “aligning their investment to their values, not because they are going to be paid”.

Starbucks is an example of the potential pitfalls.

Should the US coffee shop chain be among listed companies in a sustainable equity portfolio because of its work with fair trade coffee farmers? Or should it be blacklisted because of the perceived damage its 20 000 shops worldwide have on local businesses, or because of accusations that it did not pay enough tax in past years on its UK business?

Contradictory requirements from investors are among the biggest hurdles to employing an ESG strategy in private equity, the CDC survey shows.

Fund managers controlling assets totalling $34 trillion have signed up to abide by the UN’s Principles of Responsible Investing (PRI) launched less than a decade ago. “People tend to dismiss some of the issues as… nice to have; that is not what the research shows,” Fiona Reynolds, the managing director of UN PRI, said.

UN PRI highlights a 2010 study of 114 of the largest Chinese-listed companies. The share performance of those that underperform socially was worse than those with good ESG practices.

Similarly, a survey last year by Deutsche Bank of more than 100 academic studies showed that, globally, firms with high ratings for corporate social responsibility and ESG factors had a lower cost of capital.

“In effect, they are lower risk,” Deutsche said.

But the chances of making money out of the strategy are less clear cut. The Deutsche survey also said that 88 percent of studies of fund returns showed neutral or mixed results, and that funds with a socially responsible badge “have struggled to capture outperformance… but they have, at least, not lost money in the attempt”.

Private equity funds in emerging markets complain that the focus on ESG stops them from buying into “bad” companies and cleaning them up, potentially a lucrative move.

In addition, good practices, such as providing low-paid employees with health insurance, can be expensive.

“Some of those principles make you uncompetitive,” said one private equity fund manager, adding that ESG investing was not really necessary to help the developing world.

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